An Overview of U.S. Mortgages

The Fundamentals

What is a Mortgage?
Quite simply, a mortgage is a loan that is guaranteed by actual real estate. For instance, a Buyer wishes to borrow a sum of money from a lender in order to purchase a property. In exchange for the loan the Buyer makes a promise to pay the money back at a specified amount over a specified amount of time. If for any reason the lender is unable to pay the lender back, the lender is entitled to take ownership of the real estate. Monthly payments are the usual method of repayment of a mortgage.

What Does a Mortgage Payment Include?
Typically a mortgage payment consists of four elements: principal, interest, taxes and insurance (PITI), in some cases it will include additional expenses such as homeowner’s association fees or maintenance fees. The principal is the amount of your payment that goes directly to the debt portion of your mortgage and actually reduces the amount of money that you owe. In a standard mortgage the payments are scheduled in a way so that at the end of the agreed upon time the principal and the interest will be completely paid off. Interest is the fee that the lender charges the borrower for the use of monies loaned. Homeowner’s Insurance Fees, Mortgage Insurance and money to cover property taxes can also be collected and placed in a separate escrow account. As these bills come due, the lender uses the money accrued in the escrow account to pay them.

How Do You Qualify for a Mortgage?
In most cases lender will look at a prospective borrower in three areas to determine if they are willing to lend them money. These are known as “The Four C’s”: Capacity, Character, Capitol and Collateral.

Capacity
Simply put, this is INCOME. Are you able to make a consistent payment of the agreed amount through money that is coming into your financial accounts? Income can be from full or part time work, it can be from pensions, annuities, child support, alimony, veteran’s benefits, rental property income, disability payments, bonuses, commissions, self- employment or even retirement income. Generally, a lender will require documented proof of income, although there are lenders who will allow lenders to qualify their incomes by other methods.

Character
This is your credit history. Have you paid your previous debts in a timely fashion? Do you have a bankruptcy or other judgment against you? Even if you have a bad credit history there are potential programs available to help you to obtain a mortgage.

Capital
Capital is savings, money that can be used to purchase a property. Capital can be funds from a savings account, a gift or loan from a friend of relative, a CD or even from a 401K. Most lenders will expect you to have enough capital to pay a down payment on a property and have enough reserve to pay an additional three months of mortgage payments in the event of loss of income.

Collateral
Collateral is generally considered the property a Buyer is attempting to purchase with the loan money. An appraisal is done of a property taking into consideration the “comps” (comparable properties) in the area.

It’s important to remember that you don’t have to pick out a property to purchase in order to pre-qualify for a loan. Many experts advise that you get pre-approved for a loan before actually even beginning to shop for a property. Being pre-approved for a loan signals to home Sellers that you are serious about purchasing a home.

How Large of a Loan can you be pre-approved for?

Lender use two basic criteria to determine the amount of loan a Buyer may be eligible for:
1. Housing Expense to Income Ratio
2. Debt to Income Ratio

Housing expense to income ratio (front – end ratio) looks at what the ratio between your income (gross monthly) and your proposed monthly payment would be.

Debt to income ratio looks at the ratio between your income and your proposed monthly payment but also takes into consideration your other monthly debts. Revolving debt, such as credit cards, consumer loans, student loans, car loan will be considered but also other monthly financial commitments like alimony and child support.

More traditional lenders have programs that allow for 28/36 ratios (up to 28% percent of monthly income is devoted to housing expenses and up to 36% of your monthly income is devoted to a combination of debt and housing expenses. Some programs now offer ratios up to 29/41. A qualified lender can advise you as to the type of mortgage that is right for you. Using these ratios they will help you to decide what size mortgage you can afford, but ultimately the decision is up to you.

Closing Costs

When you “close” escrow there are usually fees associated with the closing aside from the down payment. In most cases these fees are classified in one of three ways: out –of-pocket expenses, pre-paid items and points.

Out-of-pocket expenses - generally are to pay for services provided by a third party vendors - these can include fees paid for deed recording, appraisals, tax services, attorneys, etc. The location of the property you are purchasing and the financing program you are using to purchase the property will usually determine what services you are responsible for paying. Any questions you have about third party fees should be addressed to your lender.

Pre-paid Items - are typically fees for an escrow account to pay for taxes and insurance. An escrow account to pay for taxes and insurance is not required but it has benefits for both the lender and the borrower. For the borrower it provides an easy process so the taxes and insurance can easily be paid in a monthly and thus smaller amount instead of the customary annual and biannual payments that are large and have to be budgeted for. For the lender it is an ideal way to insure that the taxes and insurance are kept up to date on their investment.

Points - represent a fee (for each percentage of your loan amount) to pay for the cost of your loan. There are two different types of points.

Origination Points - This is the cost the lender charges you for the loan.

Discount Points - This is a fee that you pay to lower your interest rate. Lowering your interest rate saves you money over the life of the loan.

Sometimes it is difficult to compare side by side loans. Frequently people look only at the interest rate and assume that is the entire picture. You should also take into consideration the points, the total amount of closing and the total pay off amount. Sometime what looks like a good deal can cost you a great deal in the long run.

Choosing a Mortgage

There many different mortgages available and it is a good idea to have an understanding of at least the basics.

Fixed-Rate Mortgages – The interest rate will stay the same over the life of the loan. This mortgage is ideal for people who are planning on owning their home for a long time, for people who are not risk takers and for people on a relatively set income.

The Positives:

1. Predictability – your payment is going to stay the same so you know exactly what you need to budget for.
2. Protection – even if interest rates rise your mortgage stays the same

The Negatives:

1. If interest rates fall your mortgage stays the same, and over the life of the loan that could end up costing you more depending upon your initial interest rate.

Adjustable-Rate Mortgages- on pre-determined dates the interest rate of your mortgage will change to reflect what the market is doing. This type of mortgage may be better for people making a short term investment or for people who are purchasing when interest rates are already high.

The Positives:

1. Usually there is an introductory rate that allows a Buyer to qualify for a larger loan as the monthly payment is smaller. This allows a Buyer to purchase more home than they might have been able to with a fixed rate loan.
2. There are generally adjustment caps which set limits on what the rate can readjust to.

The Negatives:

1. Your rate has the potential to go up in financially hard times, when you are potentially least likely to be able to afford it.

For Your Reference

PITI = Principal, Interest, Taxes and Insurance

Principal – the original amount of money borrowed. In a standard loan the percentage of principal paid in a mortgage payment will change over the life of the loan. Typically the percentage will be smaller in the first few years and grow over time.

Interest – this is the fee paid for borrowing the money. In standard loan the percentage of interest paid will be higher in the first years of the loan and eventually grow smaller over time.

Taxes – this is a fee paid by a property owner, to local government. The fee is generally a percentage based on the property’s assessed value and where the property is located.

Insurance – this is a fee for transference of risk to prevent loss. There are two types of insurance that might be included in a mortgage.

1. Homeowner’s Insurance – (also called Hazard Insurance) this type of insurance protects an owner against loss due to fire, wind, natural disasters and other hazards. Generally a lender will require a Buyer to have this type of insurance in order to protect their investment in the property.
2. Mortgage Insurance (MI) – is insurance to protect the lender against loss in case a borrower defaults on their loan. This type of insurance is usually only required when a down payment of less than 20% of the purchase price is made. FHA/HUD loan programs require a Mortgage Insurance Premium (MIP), with VA loans a funding fee is necessary, but typical conventional loans can be insured with (PMI) Private Mortgage Insurance.

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Escrow - In most cases, the money that is taken from a mortgage payment to pay taxes and insurance is held in a separate escrow account. The lender holds the funds until the bills are due and then they remit on the borrower’s behalf. A separate escrow account to pay taxes and insurance is not required and it should be noted that once the mortgage is paid in full it is the responsibility of the owner to continue to make these payments.

We at Whitney and Associates hope that you found this information helpful and enlightening. Experience the difference with Gregg and Lisa Whitney as embark on a lifestyle afforded exclusively to the rich, famous and utterly fabulous. Their exceptional service is unparalleled…Their knowledge and proven success in the La Jolla, California real estate market are beyond compare… unparalleled. For immediate answers to your questions and to begin your exciting home search in La Jolla, California, contact Gregg and Lisa directly at 848-456-3282.

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